Monday, February 10, 2014

In a previous article I discussed the positive and negative sides of stock buybacks. In general, I am interested in dividends paid to me in cash, rather than the potential for a capital gain that share buybacks might deliver. The issue with buybacks is that managements quite often have terrible timing with execution of programs. For example, when times are good and companies are flush with cash, managements start repurchasing stock at high prices. However, when times are bad, managements conserve cash and not only fail to take advantage of repurchasing stock at depressed values, but might even issue more stock to bolster liquidity. General Electric (GE) is a prime example of this phenomenon, as it spent billions repurchasing stock at prices between $35- $39/share prior to the financial crisis, only to sell half a billion shares at $22 when things got tough. This is not an example of intelligent capital allocation.

However, if management can consistently buy out other shareholders at attractive prices, and buybacks don’t mask the eroding effects of share compensation, I can view them somewhat favorably. I am particularly favorable towards companies which consistently perform share buybacks, and do not overpay for those shares. I went through the list of the top 20 buybacks for the past three years, and identified several companies which have managed to repurchase a significant amount of stock each year for the past five years.

2013

2012

2011

2010

(XOM)

$20,875

$21,131

$12,050

$18,951

(IBM)

$12,800

$10,455

$12,593

$11,601

(WMT)

$7,600

$6,298

$14,776

$7,276

(PM)

$6,524

$5,297

$4,801

$5,448

(MSFT)

$4,429

$3,116

$9,133

$8,958

Exxon Mobil Corporation (XOM) engages in the exploration and production of crude oil and natural gas, and manufacture of petroleum products. The company has raised dividends for 31 years in a row. Over the past decade, this dividend champion has managed to increase dividends by 9.60%/year. Currently, Exxon Mobil trades at 12.20 times earnings and yields 2.70%. Check my analysis of Exxon Mobil.

International Business Machines Corporation (IBM) provides information technology products and services worldwide. The company has raised dividends for 18 years in a row. Over the past decade, this dividend achiever has managed to increase dividends by 19.40%/year. Currently, IBM trades at 11.70 times earnings and yields 2.20%. Check my analysis of IBM.

Wal-Mart Stores, Inc.(WMT) operates retail stores in various formats worldwide. The company has raised dividends for 39 years in a row. Over the past decade, this dividend champion has managed to increase dividends by 18%/year. Currently, Wal-Mart trades at 14 times earnings and yields 2.60%. Check my analysis of Wal-Mart.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised dividends for 5 years in a row. Quarterly dividends increased from 46 cents/share in 2008 to 94 cents/share by the end of 2013. Currently, Philip Morris International trades at 14.80 times earnings and yields 4.80%. Check my analysis of Philip Morris International.

Microsoft Corporation (MSFT) develops, licenses, and supports software, services, and hardware devices worldwide. The company has raised dividends for 11 years in a row. Over the past decade, this dividend achiever has managed to increase dividends by 15%/year. Currently, Microsoft trades at 13.40 times earnings and yields 3%. Check my analysis of Microsoft.

These companies also return profits to shareholders through regular dividend increases as well. In general, I view those managements as some of the most shareholder friendly ones in the US. This is because they are able to grow underlying profits through careful capital allocation, and only accepting projects that have a high likelihood of hitting internal rates of return. These cash machines then shower shareholders with more cash in the form of dividends, and buy out weak hands in the share buyback process as well.

When companies reduce number of shares outstanding, this also reduces the total amount of cash they need to pay to shareholders. Therefore, if total amounts spent on buybacks and dividends stay constant each year, this would lead to an almost automatic dividend increase for the limited partners in those consistent share repurchasers. If companies also manage to boost net income over time, stock buybacks can essentially turbocharge earnings per share growth.

Now, there are probably more companies with consistent buybacks out there as well. However, I only focused on the largest ones for 2011, 2012 and 2013, and made sure that these were not one time events. I would still prefer a bird in the hand through a cash dividend payment however, although I am not opposed to managements who consistently buy out other shareholders, thus making my shares more valuable in the process. The important thing is for these managements to avoid overpaying for these shares, which is a very rare thing in corporate America.

5 comments:

DGI, I definitely agree with you that the combination of buybacks and strong dividend growth is arguably sets investors up for an extremely potent return scenario. Unfortunately, companies (like individuals) are terrible at timing the market and tend to buyback at the wrong time.

I'm a big fan of share buybacks and glad to see that I own 4 of the 5 you listed! What I look for when analyzing a company is a decreasing sharecount year to year over a period of time. With fewer shares outstanding, each share I currently own is worth a larger portion of the pie. Thus each share now has higher EPS and should be worth more in the market.Definately want to make sure companies aren't just repurchasing shares though to issue them right back to management. This does the shareholder no good.

Dividend investors should always be wary of stock buyback programs. As reported here, companies famously pay too much for their shares. But that's not all. Bought-back shares are seldom (if ever) retired, often get re-issued at lower prices, and may be meted out as compensation. Take Apple AAPL. It's in today's news for having bought back $40 billion worth of its shares. But the decline in its number of reported outstanding shares seems now to be only marginally less than what it was before the buybacks. It doesn't seem to be at all commensurate with the amount said to have been invested. So yes, indeed, share buybacks cannot mask the eroding effects of share compensation.

I am not a big fan of buybacks, and would prefer special dividends instead.

However, I do see the benefit of companies that consistently repurchase their shares, like the ones listed above. All of them have managed to repurchase their shares at pretty fair valuations. Thus I see those as outliers.

However, I find these companies to be really good stewards of shareholder capital.

I read an article once that talked about how smart MSFT is with their buybacks. When they want to buy back, they actually sell options which would force them to buy at specific prices they are comfortable with. If the options don't execute, it's extra income for the company. If it does execute, then they have bought back stock at the target price.

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